The life reinsurance spectrum

Any sad individuals who had taken a passing interest in the somewhat esoteric world of life reinsurance in recent years could be forgiven if they had come away with a view that it was peopled by two completely polarised tribes. On the one hand appears a cast of essentially worthy but slightly dull souls, who would describe themselves at cocktail parties as professional reinsurers and then watch the exodus. On the other hand appears a gang of apparently smart-talking actuaries and aggressive investment bankers, involved in what they would refer to as ‘alternative risk transfer’, ‘new markets’, or ‘alternative solutions’, or some other combination of everyday words taken out of context and jumbled together. These characters would never be seen at cocktail parties, since they would claim to be too busy ‘doing deals’. As with many things in life, let alone life reinsurance, the reality below the surface is, I believe, potentially more complex and less black and white.

Spectrum analysis In an earlier life I fear that I must have been a consultant, since I have this uncontrollable urge to demonstrate the potential diversity of life reinsurance solutions via a diagram. The accompanying diagram simply portrays a list of some of the key elements within any life reinsurance arrangement and attempts to establish a range within which the features may develop. I have broadly tried to group on the left-hand side of the diagram the expressions of the various features which represent what I would think of as the traditional end of the life reinsurance scale, the narrow end of the band or the blue end of the spectrum. Conversely, the right-hand side of the diagram has those expressions of the various features which represent a less conventional, broad band or red end of the spectrum. I am struggling with ways of describing the two limits of the spectrum, since it is very easy to inadvertently describe one or the other in pejorative terms. In practice, neither end of the spectrum or band is intrinsically right or wrong. As I hope to explain, positioning on the various scales or bands for the various features simply indicates the optimum solution chosen by a particular client. At the most basic level, life reinsurance can involve placing individual cases on a so-called facultative basis. Some insurance companies are interested in limiting their exposures on specific cases where either the sums assured are above their normal retained amounts and/or where the policyholder has medical, occupational, avocational, or geographic adverse risk features. There are some reinsurers who actually specialise in this area of operation. Moving along this particular spectrum, it is very common for insurance companies to arrange reinsurance treaties or agreements to cover risks associated with certain new products. In this instance, all of the policies written under a specific product line, and falling within the particular limits of the reinsurance treaty, would be covered automatically by the reinsurer. At the far end of this spectrum entire portfolios of existing and new business, perhaps encompassing a range of product lines, could be reinsured. It is possible for an insurer to be involved in a mixture of arrangements along this spectrum at any given time. Clearly, in terms of the potential financial impact on an insurer, the reinsurance of entire portfolios of both existing and new business offers far more prospect of some serious financial engineering than the reinsurance of individual cases.

New versus established business Associated closely with the above factor is the question of whether life reinsurance has a primary focus upon new business, or whether it is employed across books of in-force business. There are insurers and reinsurers which tend to focus mainly at one end of this spectrum or the other. As a gross generalisation, it is also possible to associate relative levels of active monitoring and review of reinsurance arrangements along a similar spectrum. Broadly, it is true to say that whole portfolio reinsurance arrangements tend to be more actively monitored and reviewed than single case or product treaties. This not only reflects the sheer size of portfolio arrangements but quite often reflects the changes in the financial drivers which had created the need for the deals in the first place. There are certainly exceptions to this precise trend line. In particular, some insurers have begun to review their product-related treaties regularly. Depending upon your perspective, this is either intended to keep the naturally lazy reinsurers competitive or grind the poor unrewarded reinsurers into the ground. Which leads neatly to the next factor provision of services. Service provision Historically, a number of reinsurers have developed strategies which have involved the provision of a wide range of support services (eg underwriting, product development, claims management, pricing), in addition to the core risk cover. Such services have been provided ‘free of charge’, ie the costs were simply bundled up or lost within the risk reinsurance pricing. Once again, as a generalisation, it is fair to say that service provision tends to be less important, or simply not required at all, as you move along the spectrum toward whole portfolio reinsurances. Such arrangements have normally been driven primarily by financial factors and not service needs. In addition, some insurers have preferred in recent years to unbundle services from basic reinsurance, in order to monitor costs separately and, in some instances, formally to outsource certain functions. However (and this is the link to the previous point), some insurers have consciously maximised the value of the historic bundled approach to reinsurance by negotiating the lowest possible reinsurance terms and simultaneously obtaining the maximum amount of service provision. Once again, depending upon your perspective, this is either shrewd negotiating by the insurers or a financially sloppy, market-share-led approach by the reinsurers involved. The development of service provision by life reinsurers has generally led to a strong focus upon the products being developed by the insurance company clients. Conversely, a by-product of this strategy has been a general lack of focus upon the specific mechanics of the reinsurance solutions or products. Traditional life reinsurance treaties have tended to follow a proportional methodology (quota share or surplus). Whole portfolio reinsurance arrangements, however, tend to employ more creative reinsurance solutions, such as non-proportional covers (stop loss, excess of loss), surplus relief and capital markets solutions (securitisations). Associated with the above point is the way in which the impact of any reinsurance arrangement is reflected in the accounts of the insurance company involved. Case-by-case or product-related treaties would, by their nature, be focused upon ongoing claims experience and, therefore, influence revenue account or income statement results. By contrast, whole account reinsurance treaties and, in particular, capital markets solutions produce results focused upon the balance sheet and capital management.

Increasing risk aversion Over recent years many life reinsurers have seemed to become more and more risk averse. In extreme cases, rather than promote their expertise as risk managers, some reinsurers have appeared to want to avoid real risk entirely. For whole account reinsurance arrangements and many capital markets style solutions, the best results are obtained for the client only when the reinsurers are willing and able to accept a real and significant transfer of risk. In addition to the technical issues covered above, there are some less tangible corporate and personal issues which can have as much, if not more, influence upon the nature of reinsurance arrangements. These factors can also be seen as ranging across a spectrum or bandwidth. An insurance company with a strong actuarial/product development function will often be biased toward a product-led reinsurance treaty structure. By contrast, a company with a dominant corporate financial area may well take a wider perspective and be using reinsurance as an integral tool of overall capital management. Additionally, if an insurance company has a rather rigid corporate structure, where people protect their local turf vigorously, then it is less likely that it will be moved away from the more traditional life reinsurance approaches. Companies with more fluid structures and with corporate behaviours which promote sharing of ideas and goals, are more likely to use reinsurance in a broader way, to achieve major corporate financial objectives.

Individual objectives Finally, but by no means least in terms of significance, are the personal goals and objectives of those involved in placing reinsurance arrangements. In situations where those concerned with reinsurance placement are explicitly measured by the terms negotiated for specific product treaties, then it is very likely that they will work hard to squeeze the last percentage point from reinsurance rates and extract the maximum amount of service support for those treaties. If the people involved in the reinsurance buying process are rewarded according to the achievement of wider, corporate financial goals and/or improvements in the company’s share price, then it is much more likely that reinsurance will be used as a tool of financial management, even if it is still firmly negotiated. I hope that all the above comments, not to mention the slick diagram, will have helped to portray the potential scope of life reinsurance techniques and demonstrate that those techniques flow continuously across a spectrum, rather than reside within discrete boxes. You will now appreciate that life reinsurers are neither just grey, dusty technicians, nor simply spivvy smart alecs. We are actually wide-ranging, well-adjusted, lovable human beings!